Question

The efficient market hypothesis is interpreted in a weak form, a semi-strong form, and a strong form. First, explain the efficient market hypothesis. Then, differentiate between the three forms. Which form is most commonly accepted?

Why? Do agree? Disagree?

Why? What evidence did you find to support your opinion?

Answer 1

According to Efficient Market Hypothesis (EMH), at any given point in time the asset price will reflect all the relevant information and it is not possible to beat the market.

There are three form of EMH

1. Week Form efficiency : It states that price of secuity fully relfects all the public information and there is no relation of historical price with the future price. It also says that we cannot acheive excess return using technical analysis.

2. Semi Strong Form Efficiency : It assumes that as soon as there is news in the market, current price of the stock changes rapidly to absorb that information so that no excess return can be earned using that information. It assumes that stock price factored all the market and non market public information.It says that no excess returns can be achieved using fundamental or technical analysis

3. Stong Form Efficiency ; In this form, it is assumed that stock price will reflect all the information be it public or private and no one can earn the excess return. It says that current stock price reflect all the market non market public or private information and no one can use any of the inside information to achieve excess return.

Semi strong form is most widely accepted in the market because it indirectly says that private inside information may result in excess return to those people those people who has that information.

I completely agree with that because no matter what, there will always be asymmetry in terms of the news available in the market. Managers working in the company will have inside knowladge of the company which a common shareholder will not have. That is why senior managers who has access to this kind of knowladge has to sign NDA with the company, But they can somehow play around and can make use of this excess information. ( This is what is known as insider trading). This is happening around the world and classic example of this is Rajat Gupta case.